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Burning Down His House

“They drained us of cash,” Fuld later told an associate, who added, “They fucked us.”

Lehman had planned to announce its third-quarter results on September 18. “The feeling was, if we waited, the market would drill us to a penny stock,” said one executive. So on September 10, it reported its third-quarter earnings, a loss of $3.9 billion. Simultaneously it unveiled a plan to go forward. It was putting a majority stake in its investment-management division up for sale and spinning off its troubled commercial-real-estate assets into a separate company.

There were a lot of moving parts, but Fuld tried to sound confident. “We have a long track record of pulling together when times are tough,’’ Fuld said on a conference call with analysts. “We are on the right track to put these last two quarters behind us.’’

“I really think Fuld believed it,” said one manager.

Fuld was not even at the table as Lehman’s fate was decided, a tactical move that nonetheless told a larger story. Starting Friday night, September 12, a series of meetings was convened at the Fed’s concrete fortress on Liberty Street, which sits atop the largest stockpile of gold in the world. Paulson and Tim Geithner, head of the New York Fed and now secretary-designate of Treasury, had summoned the heads of the country’s largest investment banks. McDade and Kirk represented Lehman at the Fed that weekend. By then, McDade was calling most of the shots.

Fuld stayed back in the office and peppered Paulson, Geithner, and members of their teams with phone calls. “He would offer something,” said one person who was with him. “It would come back ‘no.’ He’d take a deep breath, then come back with, ‘How about this? How about this? How about this?’ ”

Lehman was barely alive. And in just the past week, the financial world had become a significantly scarier place. AIG, the giant insurer, also teetered on the edge of bankruptcy. And Merrill, everyone believed, was on life support—Merrill had, as one official put it, a bigger “pile of shit” on its books than Lehman. Neither Goldman nor Morgan Stanley looked entirely stable.

“The world is changing,” an exec told Fuld. “We have to rethink our business model.” “You’re too conservative,” Fuld replied. “You don’t want to take risk.”

And the political climate had turned ugly. Taxpayers and their congressmen rebelled; they resented footing the bills for a profligate, money-drunk Wall Street. Government officials knew what was in the air. That weekend, they were acutely sensitive to the delicate balancing act: public ire against the future of America’s banking system. So, as one Treasury official explained to the banks, “we didn’t want people to come with the expectation that we were going to fill every hole, solve every problem.” Lehman feverishly pursued a sale that would save it. “We thought we had an understanding with Bank of America on Friday night,” said one Lehman official. By Saturday, though, Bank of America’s CEO Ken Lewis had stopped returning Lehman’s calls.

Lewis, it turned out, had jumped tracks. Thain, now Merrill’s CEO, had supposedly had an epiphany that Saturday—as recently as the previous Wednesday he’d resisted a plan to sell his company. But sitting at the Fed, he panicked. He called Lewis, who’d long been interested in Merrill’s 16,000 retail brokers, and on September 15 they announced a deal. In the dawning era, retail banking was much more attractive than the I-banking model Lehman offered.

That left as a potential buyer only Barclays, the London-based bank that had entered the picture just a few days earlier. Barclays told Treasury it wanted Lehman, but with conditions. “It wanted to scoop out the good assets,” one senior Treasury official says. It wanted to leave behind over $50 billion in bad assets.

Some at Lehman argued that it had plenty of assets to back a loan, the same type that sealed the Bear Stearns sale. But the government wasn’t working on that assumption. “Bank of America, Barclays, and a number of people on the Street had said, ‘With Lehman’s assets, you’re going to lose money,’ ” explained a Treasury official. “The Fed cannot lend money if the indication is that it’s going to lose money.”

Paulson and Geithner sequestered the heads of the leading investment banks in one of the Fed’s many grand, wood-paneled conference rooms. The bankers feared the consequences of a Lehman meltdown, but they were more worried about their own futures. “It’s like Louis the XIVth said: Alone against everyone,” said one Lehman executive.

“Why should we save Lehman?” one asked. “What about AIG? Where does it end?” By Sunday morning, Geithner and Paulson seemed to have persuaded the bankers to guarantee Lehman assets, up to perhaps as much as $70 billion. That appeared to put the Barclays deal on track.